It can happen to the best of companies. When China was opening up to foreign investment in the nineties, some of the biggest companies in the world stampeded into the country in a quest for seemingly unlimited profits offered by an increasingly affluent population of 1.3 billion. Brewers, retailers, automobile manufacturers, investment bankers, hoteliers; They all entered China almost en bloc. These were multinationals experienced in cross-border commerce but many came unstuck, their hopes dashed, or at least delayed, for a multitude of reasons.
Red tape, interference from local authorities, corruption, cultural differences, difficulties of distribution, shortages of appropriately trained manpower: the obstacles were many and varied. Many of these pioneering western companies paid a high price and withdrew, considerably the poorer.
But 20 years later, China and the surrounding countries of Asia have become almost the bolthole of companies of all kinds as they seek the profits that are increasingly hard to find in slower-growing Europe and North America. Some of the biggest brands in the world owe their current buoyant revenues to markets that once proved such a challenge to the pioneers. They include Tesco, Renault, Michelin, Diageo, LVMH, Airbus and Boeing among many others.
Challenging as overseas expansion is for any company, the lesson of the economic boom in China and the broader Asia-Pacific region, Latin America and the Middle East and, coming rapidly over the horizon, north and sub-Saharan Africa, is that today’s big opportunities are to be found in fast-growing economies. The challenging issue is how best to tap those opportunities.
Numbers tell the story
But first, the argument for offshore expansion is pretty much evident in the numbers. Emerging markets will grow by an average six percent a year between now and 2018, according to Boston Consulting. By 2020, about 35 percent of all consumer spending, equivalent to $20trn, will come from emerging markets. (At present it’s 25 percent, higher than most people believe.)
For companies producing consumer durables, the arguments are even more compelling. No less than 270 million new households will enter the global consumer market by 2020, all from emerging markets. That’s an increase of 40 percent. Thus the prospects are immense but here’s the sting in the tail. “The obstacles to operating in these high-growth markets are significant and the skills needed to win in them are quite different from those needed in developed markets,” adds Global Consulting in a recent study. Unsurprisingly, even the bosses of hardened multinationals find the challenges daunting. Although most recognise overseas growth is the only option, just 13 percent of senior executives “feel prepared to fully capture this opportunity”, the consultancy found in 2012.
Shoals and reefs
The winners will be those who make the fewest and least serious errors. Here’s a short list of the pitfalls compiled from an analysis of the shoals and reefs that have caught out parvenu companies. Most arise from differences in language, commercial law, accountancy, regulation, geography, logistics, marketing, standards of governance and corporate integrity, availability of credit, bureaucracy, pricing and employment, treasury functions.
To take just language, it’s no accident that Spanish infrastructure-building companies such as Obrascon Huarte Lain, Ferrovial and Abengoa have booked the lion’s share of the major airport, rail, road and energy projects in Latin America rather than English-speaking businesses. Similarly, French-speaking companies, especially banks, have strong presences in francophone African countries such as Morocco and Tunisia. And for the same reason, English-speaking businesses have excelled in the old British Empire, now the Commonwealth.
To make offshore expansion easier – or rather, more predictable because it’s never easy – Boston Consulting has developed a checklist for assessing the risks and rewards offered by new markets, whether emerging or not. Called the ‘Global Readiness Index’, it aims to provide clues to how well a company is likely to perform. Under thirteen ‘critical dimensions of globalisation’, the index provides a snapshot of the company’s assets and handicaps.
They comprise of leadership, vision and strategy, governance and organisation, product offering and/or value proposition, branding and marketing, insight into consumer behaviour, the channels of sales and distribution, availability of talent in the new market, risks and regulations, decisions about mergers and acquisitions or partnerships, strength of innovation through research and development, best-cost economics for sourcing or manufacture.
All up, it’s quite a checklist. Yet every element requires the utmost consideration. “For many companies, even those that have been operating overseas for decades, expansion into emerging markets puts them outside their comfort zone,” explained Boston Consulting’s chief executive Hans Paul-Burckner in early May.
Emerging markets are in a constant state of flux and today’s China, already very different from the China of the nineties, provides a good example. Take the ever-changing issue of employment. “In years to come, multinationals will face new challenges in their China operations”, warns US-based management consultancy Wharton Group. Pointing out that, until now, most multinationals gave their Chinese general managers relatively basic jobs, the think tank insists that just won’t do in the future.
Senior Chinese executives were expected to take on the “relatively straightforward task of either selling his multinational’s products in that country or helping the parent firm establish operations to leverage China’s strength as a low-cost producer”, says Wharton.
Now though, multinationals must develop more educated and experienced Chinese managers and deploy them in a global role, for instance by meeting foreign customers and lending their intellectual knowledge to the parent company’s global operations.
“These forces are coming together to produce a significant change in the role of the China general manager”, explains Jim Hemerling, Boston Consulting’s vice president in Shanghai. “That person now has to be the impresario or orchestrator of a much more complex set of management demands.”
Product liability competition rules
Or take commercial law, or rather just one aspect of it. An issue of increasing importance is product liability and its nature and significance varies greatly from region to region, country to country.
“A physical risk is a universal risk,” explains Martin Sijmon, risk manager for Sweden-based truck and bus manufacturer Scania. “A fire in a factory in Brazil is the same as a fire in France because there are common elements in these plants. But product liability is much more complicated. If a Scania school bus were to crash in UK, the company’s exposure would likely be very different if that were to happen in, say Africa. Not only are the laws different, so is the culture in terms of the value that is put on people’s lives, unpleasant as it is.”
Competition law is another issue. All over Asia, young competition watchdogs are getting tough. Hong Kong’s imminent competition watchdog, for example, will have extremely sharp teeth. Any “abuse of substantial market power”, to use its own phrase, could expose the offending company to penalties as high as ten percent of local turnover for up to three years. It will be one of the toughest financial penalties of any competition authority.
Then there’s treasury functions, a vital cross-border pipeline for far-flung companies that are routinely mismanaged. According to a new study by consultancy McKinsey, companies with cross-border operations typically end up with far too many accounts. The rough average for global organisations is about 850 accounts while even the most disciplined corporate treasuries typically run around 200. One shocked chief financial officer of a heavy-materials company discovered after a global test that he had 300 accounts in 25 countries. And between them, they held a three-month daily average balance of over $80m, which was doing nothing for the company but a great deal for the banks.
Plan of attack
Companies have more than one way to tackle new markets. In fact there are three, according to Beat Simon, European chief executive of Agility, a multinational logistics company with 22,000 employees in 100 countries. He identifies ‘outsourcing’ (contracting an aspect of the business to a third party which may or may not be in another country), ‘offshoring’ (relocation of a service or production process to another country) and – possibly new to many – ‘nearshoring’. The last is really offshoring, but to a near neighbour.
But to start with offshoring, where the advantages may seem obvious. “During the initial stage of offshoring, one of the main decision factors is the substantial percentage of labour cost in the manufacturing process of some goods”, explains Simon. “By moving a production process to [another country], manufacturers could be more profitable as well as more competitive by greatly reducing that part of the production cost. A counterbalancing factor from the logistics perspective is the increased cost in the supply chain in terms of complexity, lead time and transportation.”
Dyson, the UK-based vacuum-cleaner manufacturer, did exactly that by shifting most of its production to Malaysia a few years ago. As founder Sir James Dyson pointed out at the time, he could buy scientists there for the same wage bill that hired technical staff in Britain.
Dyson’s experience illustrates exactly what Agility’s Beat Simon points out. “In addition to low labour costs, there were many other enticements to offshore,” he says about the early stampede to China and other lower-cost manufacturing locations. “Namely less complex building regulations, less strict environmental regulations, huge potential economies of scale, or more straightforward labour contracts and labour regulations.”
But, as emerging-market economists point out, those attractions could be diminishing as costs in such countries rise. According to Boston Consulting, more than a third of American manufacturing executives “either plan to or are actively considering moving products back from China.” The percentage rises to 48 percent among companies that do more than $10bn in revenue. And there are some big names there including GE, Boeing, Sirkin, Ford, and Masterlock.
In many cases this is more of a judicious, partial withdrawal than a wholesale one. “China’s labour costs, other costs and logistical expenses are soaring rapidly, while US labour costs are beginning to stabilise at a comparable level with a growing China when all factors are considered,” the consultancy explains.
Green and clean
Also changing is Asia’s reputation for softer environmental regulations that had the effect of reducing start-up costs. Under pressure from international and their own environmental agencies, governments are in a hurry to enforce much greener standards on companies because the rampant exploitation of fossil fuels has contaminated air and river ways and visibly reduced the benefits of economic growth.
“They are under pressure to reduce air pollution and are implementing new rules and regulations to reduce and mitigate the effect of greenhouse gas emissions”, points out Surupa Matho of UK-based Ovum consultancy group in a new report.
Under the Durban rules agreed in late 2011, most Asian governments are working to greatly reduce carbon emissions by 2020. “Increasing regulation has forced companies to develop and incorporate carbon reduction strategies,” adds Matho. “Demand has placed sustainability strategy on the mainstream agenda.”
History matters
Very probably, few European companies other than Spanish and Portuguese-speaking ones would contemplate entering Latin America if it were not for the El Dorado of bigger-spending households. Language, laws, labour relations, governance, stock markets: they could hardly be more different from those at home base.
Worse, rogue nations such as Venezuela send the wrong message. It would be a brave company that would open up in Venezuela right now. The current leader in outright appropriation, president Hugo Chavez, seized just under 500 companies last year including, preposterously, a professional basketball team sponsored by Conferry. (Latin American think tank Econoalitica estimates the economic damage over the last seven years at $22bn).
However, Venezuela is not typical of Latin America. The region is rapidly adopting western-style systems of public and private governance under pressure from international agencies such as the World Bank. For many European companies, Latin America abounds with commercial opportunities, even Argentina. UK stadium-design specialist, Populous, heads a consortium building the $100m Velociudad theme park in the country.
For UK’s Oxitec, an Oxford-based start-up specialising in mosquito control, it’s important to approach Brazil with an open mind. “Brazil is particularly keen to embrace technological advancements and we have found federal and state institutions and companies keen to engage”, chief executive Hadyn Parry told the writer. “From a science viewpoint it is very strong. For any company going to Brazil there is a lot to learn from the country.”
Paraguay is another nation with economic promise, where rules on capital adequacy for its banks are some of the toughest in the world and would shame institutions in USA, UK and Europe. As Conor McEnroy, chairman of Asuncion-based Sudameris bank, told the writer: “Tier one capital must be 13-14 percent by law, but the average tier one is 17 percent. We don’t do funky stuff in Paraguay. Regulation is plain vanilla, black and white, no grey”.
And with about a million US citizens living there and keeping pressure on the stock market and other regulatory authorities, Mexico has steadily adopted American techniques in corporate governance and is moving towards the Sarbanes-Oxley standards that were implemented in USA after the Enron and other corporate scandals. Peru is also turning into a preferred location for Europe and UK investors. Roughly a score of the top 100 companies on the Financial Times FTSE index, for example, have direct investments in Peru.
